Nigeria: A Primer on the Hazards of Country Risk

Nigeria has 37 billion barrels of crude oil reserve and is Africa's largest oil producer. The country also boasts 187 trillion cubic feet of proven natural gas reserves, the ninth-largest reserve in the world.

Nigeria has all the right geology for oil and gas. But geology isn't everything.

The best geology in the world can still be a terrible place to put your money if other risks threaten to steal all of a project's profits and potential - and country risk can pose precisely that threat.

Think about it this way. In considering any business venture, you need to know several key parameters, such as how much it will cost to establish the operation, how much you will produce, and what percentage of your profits the government will take. In Nigeria, you cannot calculate any of these metrics with confidence because the rules are so complex and corrupt.

Now a new Petroleum Industry Bill (PIB), being debated in Nigeria's parliament after some 15 years in the works, is supposed to change all of that. The new PIB is intended to clarify, codify, and clean up an industry where corruption and uncertainty are killing investment interest.

Unfortunately, the new PIB is just as bad as the 13 separate rules it is set to replace. It would solidify a structure that operates on bribery and favors and it would take so much profit from producers that the effort would no longer be worth the risk.

It would scare away the oil and gas investors that it is supposed to attract, and in doing so would doom Nigeria's troubled energy sector to continue on its current downhill trajectory.

I want to talk about Nigeria today not just to scare investors away from one particular country, but to remind us all that country risk can easily make or break a project. No matter how fantastic the geology or how large the reserve, if the government of the day is corrupt, desperate for income or popularity, straight-up greedy, or any combination thereof, best just walk away with your money.

If you invest in a country with that kind of government, you might as well have just handed your dollars to the government on a golden platter. And if you don't know how much risk a country bears, best to find out from an energy investment team that travels the world to assess country risk firsthand.

Setting the Stage: Nigeria's Oil Nightmare

Nigeria officially produces 2.7 million barrels of oil a day, but no one has any confidence in that number. Oil is stolen at a shocking rate in the country, so figures from traders on Nigeria's saleable oil show output well below that government figure.

More generally, information about Africa's biggest oil industry is an opaque myriad of numbers, and no one knows which ones are accurate. Experts say Nigeria could easily measure how much oil it produces but it chooses not to... because if there were an authoritative figure, the truly horrifying scope of corruption would be exposed.

Mismanagement, theft, and corruption cost the industry billions of dollars a year. Heavy government subsidies for petrol add another $16 billion to the annual tab. In addition the country's four refineries work far below capacity, forcing Nigeria to import most of its fuel.

A new report, commissioned after the country erupted in protests in January when the government tried to reduce fuel subsidies, states oil-theft volumes have climbed to the astonishing level of 250,000 barrels a day, or 10% of production. Some months as much as 400,000 barrels are stolen every day. Even more shocking: 40% of refined petroleum products - either refined in Nigeria or imported - that are moved through state-owned pipelines are lost to theft and sabotage.

Small-scale pilfering has been endemic in Nigeria since the late 1990s, but now more sophisticated thieves are stealing directly from export terminals, tank farms, refinery tanks, and ports. The stolen oil is worth some $6 billion annually.

Of course, writing a sweeping new bill to regulate an industry rife with corruption and vested interests is not easy. That's why the PIB has been in the works for more than a decade. Five years ago the bill made it to Nigeria's Parliament, but disagreements between the administration, oil majors, and lawmakers stymied its passage.

With almost no regulatory or fiscal certainty on the table, Nigeria has become a dangerous place for Big Oil to do business. While they wait for that certainty, oil majors have held off on many billions of dollars in investment - one expert estimates the industry lost $28 billion in investments in 2011 alone.

As a result, oil output is about the same as it was a decade ago, and only three exploratory wells were drilling in 2011, down from more than 20 in 2005. The government has not held a licensing round for five years.

Nigeria's New Oil and Gas Bill

The Nigerian government says its main goals in developing new regulations for its oil sector are to clean up a corrupt industry, clarify a confusing sector, and encourage new investment.

Unfortunately, the PIB accomplishes none of those goals.

I won't embark on a full dissection of the bill. What I will do is point out the most glaring of problems - starting with the fact that the PIB would give a few select politicians huge powers within the sector.

Here's a good example: the president would have the power to grant licenses and leases without a competitive process - or any kind of process, for that matter. This leaves the door wide open for everyone to continue practicing the political favoritism and corruption that has crippled the industry in the past.

The president would also have the power to set special tax rates for any projects he deems as strategic to the nation. Imagine if Romney or Obama were given this power...

Alongside a president who can hand out licenses as he pleases and siphon funds from any project he deems strategic, the Minister of Petroleum is granted draconian powers to determine rentals and royalties. There are two huge problems with this. First, giving immense powers to individuals only encourages bribery and corruption. Second, companies thinking of developing a new project have no certainty around their rental and royalty payments if the minister creates her own arrangement for each project.

Well, that's a slight overstatement. Companies would know the minimum level of government take from new projects - and it's too high. Executives from a wide range of Big Oil companies, including Royal Dutch Shell and Exxon Mobil, have said publicly that the tax terms outlined in the PIB render offshore oil and gas projects unviable. Exxon is the second-biggest offshore operator in the country, and it says it will not invest any more in deepwater projects if the PIB is passed.

Part of the problem is that oil companies demand better fiscal terms to operate in places like Nigeria, to compensate for the extra risks posed by piracy, kidnappings, theft, and corruption.

Instead of providing that kind of financial incentive, the PIB absolves oil companies of any responsibility for environmental damage caused by sabotage... which would mean that no one is accountable for such damage. The environment will continue to be destroyed, and the sabotage will continue.

More than half of Nigeria's 160 million people earn less than $2 a day. From that perspective, rampant pipeline sabotage and bunkering in the Delta region are understandable: the Nigerians who commit these acts are helping themselves to a portion of their country's resources.

The only way to ease this kind of activity is to truly share profits with local communities. To that end, the PIB would create a Petroleum Host Communities Fund. Producers would have to give 10% of their after-tax profits to this fund - disbursements that would be credited against other payments to the government to not increase overall government take - and the funds thus generated from onshore and shallow water offshore production would be distributed to affected communities.

It sounds great... but unfortunately, just like so many other parts of the PIB, the Host Communities Fund is a great idea that is structured so as to invite political interference. The PIB does not define how the funds will be distributed, putting another lever in the hands of the president and his ministers. Communities would be pitted against each other in a race for favor with the government, and the president could easily use this race for favor to achieve his own ends within the Delta.

Also left in the hands of government: a whole whack of oil-related assets. International advisors had pushed for a PIB that incorporated the Nigerian National Petroleum Corporation (NNPC) and then partially privatized it, following the example of Brazil's Petrobras. Doing so would require the company to be managed like any other international oil company, with minimal political interference.

Instead, the PIB would break the NNPC into three entities and privatize only two. The management company left in government hands would contain major oil assets and revenue streams that would remain subject to heavy political interference.

And I mean heavy. The NNPC currently controls every aspect of Nigeria's oil and gas industry, from exploration and production to refining and pipelines, and it will continue to do so if the PIB is passed. But this is a company that is regularly listed as one of the most closed oil companies in the world. In fact, a joint report from Transparency International and the Revenue Watch Institute judged the NNPC to have the worst record of 44 national and international companies examined. Audits and examinations regularly produce descriptions like "accountable to no one" and "a slush fund for the government."

The PIB is a failure on almost every front. Oil companies considering Nigeria are looking at the PIB and walking away. Nigeria - home to the eleventh-largest oil reserves and ninth-largest gas reserves in the world - will continue to see its production pinched between declining investment, greedy government take, and massive theft. The decimated environment of the Niger Delta will see no savior, and the people who live there will continue to live in grinding poverty while corruption and theft steal billions every year.

It's a tragedy for Nigeria and a warning for oil investors. The warning is one I repeat regularly: never underestimate country risk. Greedy governments and corrupt politicians can and will take every cent of profit from oil and gas projects in their lands, leaving companies bankrupt and investors robbed.

Nigeria is by no means the only country pinching its oil sector. Venezuela and Argentina are also robbing their energy producers to buy popular affection, along with a raft of other nations.

However, there's a silver lining. Every time a country screws up its oil sector, the Big Pinch tightens: there is a bit less oil available to feed an oil-hungry world and a bit more pressure on exporters to earn even more from each barrel that is available. The result? Oil prices that have nowhere to go but up.

Anyone who understands the risks and makes the right investments will be able to ride those prices to huge returns. However, country risk is hard to assess from afar. That's why my ground team travels the world, from Albania to Iraq, Africa to Asia, going wherever a prospective energy story takes us to understand the situation firsthand and separate fact from fiction.

It would be impossible for every investor to assess every prospective investment in person - which is why we do it for you. If you are an interested and active energy investor, consider a subscription to my flagship newsletter, Casey Energy Report, and travel with us on the journey to find the best investments in the global energy sector.

What a headline! Using data from the US Energy Information Administration, the reporter behind this article suggests that surging US oil output could push the US past Saudi Arabia and into top spot in the global oil-production rankings within a few years. Citibank also provides some data, predicting that US production could reach 13 to 15 million barrels per day by 2020, making North America the "new Middle East."

If this headline seems a direct rebuttal of the article above - that's because it is. This writer challenges the article, saying that anyone who "actually examined figures available from the US Energy Information Administration website carefully instead of simply parroting oil industry sycophants" would have ended up with a headline more like: Marginal gains in US oil production mean continuing high prices and imports for Americans. The writer explains that there are several ways to define oil supply, and the one used to suggest that US is catching Saudi Arabia in oil production includes natural-gas plant liquids and biofuels, making for a very misleading conclusion.

The wonders of US shale gas continue to amaze. Fresh evidence daily suggests that swaths of the American industry are gaining a massive and lasting advantage in energy costs over global rivals - and those advantages are demolishing assumptions about US economic decline.

Hurricane Sandy is providing a clear reminder of the vulnerabilities of offshore oil production to weather. Predicted to be the largest storm ever to hit the North American mainland, Sandy is prompting refineries to close and oil analysts to reduce consumption estimates in the face of canceled flights, a dearth of commuters, and an all but shut-down road transportation sector.